Quarterly report pursuant to Section 13 or 15(d)

Hedging Transactions and Derivative Financial Instruments

v3.20.2
Hedging Transactions and Derivative Financial Instruments
 9 Months Ended
Sep. 25, 2020
Hedging Transactions and Derivative Financial Instruments  
Hedging Transactions and Derivative Financial Instruments HEDGING TRANSACTIONS AND DERIVATIVE FINANCIAL INSTRUMENTS
The following table presents the fair values of the Company's derivative instruments that were designated and qualified as part of a hedging relationship (in millions):
 
Fair Value1,2
Derivatives Designated as Hedging Instruments
Balance Sheet Location1
September 25,
2020		 December 31, 2019
Assets:      
Foreign currency contracts Prepaid expenses and other assets $ 17  $ 24 
Foreign currency contracts Other assets 73  91 
Interest rate contracts Prepaid expenses and other assets 4  10 
Interest rate contracts Other assets 683  427 
Total assets   $ 777  $ 552 
Liabilities:      
Foreign currency contracts Accounts payable and accrued expenses $ 46  $ 40 
Foreign currency contracts Other liabilities 10  48 
Commodity contracts Accounts payable and accrued expenses 1  — 
Interest rate contracts Other liabilities —  21 
Total liabilities   $ 57  $ 109 
1 All of the Company's derivative instruments are carried at fair value in our condensed consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 15 for the net presentation of the Company's derivative instruments.
2 Refer to Note 15 for additional information related to the estimated fair value.
The following table presents the fair values of the Company's derivative instruments that were not designated as hedging instruments (in millions):
 
Fair Value1,2
Derivatives Not Designated as Hedging Instruments
Balance Sheet Location1
September 25,
2020		 December 31, 2019
Assets:      
Foreign currency contracts Prepaid expenses and other assets $ 34  $ 13 
Commodity contracts Prepaid expenses and other assets 19  8 
Commodity contracts Other assets 4  2 
Other derivative instruments Prepaid expenses and other assets 8  12 
Other derivative instruments Other assets 3  1 
Total assets   $ 68  $ 36 
Liabilities:      
Foreign currency contracts Accounts payable and accrued expenses $ 41  $ 39 
Commodity contracts Accounts payable and accrued expenses 36  13 
Commodity contracts Other liabilities 11  1 
Other derivative instruments Accounts payable and accrued expenses 5  — 
Total liabilities   $ 93  $ 53 
1 All of the Company's derivative instruments are carried at fair value in our condensed consolidated balance sheets after considering the impact of legally enforceable master netting agreements and cash collateral held or placed with the same counterparties, as applicable. Current disclosure requirements mandate that derivatives must also be disclosed without reflecting the impact of master netting agreements and cash collateral. Refer to Note 15 for the net presentation of the Company's derivative instruments.
2 Refer to Note 15 for additional information related to the estimated fair value.
Credit Risk Associated with Derivatives
We have established strict counterparty credit guidelines and enter into transactions only with financial institutions of investment grade or better. We monitor counterparty exposures regularly and review any downgrade in credit rating
immediately. If a downgrade in the credit rating of a counterparty were to occur, we have provisions requiring collateral for substantially all of our transactions. To mitigate presettlement risk, minimum credit standards become more stringent as the duration of the derivative financial instrument increases. In addition, the Company's master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty. To minimize the concentration of credit risk, we enter into derivative transactions with a portfolio of financial institutions. Based on these factors, we consider the risk of counterparty default to be minimal.
Cash Flow Hedging Strategy
The Company uses cash flow hedges to minimize the variability in cash flows of assets or liabilities or forecasted transactions caused by fluctuations in foreign currency exchange rates, commodity prices or interest rates. The changes in the fair values of derivatives designated as cash flow hedges are recorded in accumulated other comprehensive income (loss) ("AOCI") and are reclassified into the line item in our consolidated statement of income in which the hedged items are recorded in the same period the hedged items affect earnings. The changes in the fair values of hedges that are determined to be ineffective are immediately reclassified from AOCI into earnings. The maximum length of time for which the Company hedges its exposure to the variability in future cash flows is typically four years.
The Company maintains a foreign currency cash flow hedging program to reduce the risk that our eventual U.S. dollar net cash inflows from sales outside the United States and U.S. dollar net cash outflows from procurement activities will be adversely affected by fluctuations in foreign currency exchange rates. We enter into forward contracts and purchase foreign currency options and collars (principally euro, British pound sterling and Japanese yen) to hedge certain portions of forecasted cash flows denominated in foreign currencies. When the U.S. dollar strengthens against the foreign currencies, the decline in the present value of future foreign currency cash flows is partially offset by gains in the fair value of the derivative instruments. Conversely, when the U.S. dollar weakens, the increase in the present value of future foreign currency cash flows is partially offset by losses in the fair value of the derivative instruments. The total notional values of derivatives that were designated and qualify for the Company's foreign currency cash flow hedging program were $8,809 million and $6,957 million as of September 25, 2020 and December 31, 2019, respectively.
The Company uses cross-currency swaps to hedge the changes in cash flows of certain of its foreign currency denominated debt and other monetary assets or liabilities due to changes in foreign currency exchange rates. For this hedging program, the Company records the changes in carrying value of these foreign currency denominated assets and liabilities due to changes in exchange rates into earnings each period. The changes in fair value of the cross-currency swap derivatives are recorded in AOCI with an immediate reclassification into earnings for the change in fair value attributable to fluctuations in foreign currency exchange rates. The total notional values of derivatives that have been designated as cash flow hedges for the Company's foreign currency denominated assets and liabilities were $2,700 million and $3,028 million as of September 25, 2020 and December 31, 2019, respectively.
The Company has entered into commodity futures contracts and other derivative instruments on various commodities to mitigate the price risk associated with forecasted purchases of materials used in our manufacturing process. These derivative instruments have been designated and qualify as part of the Company's commodity cash flow hedging program. The objective of this hedging program is to reduce the variability of cash flows associated with future purchases of certain commodities. The total notional values of derivatives that have been designated and qualify for this program were $11 million and $2 million as of September 25, 2020 and December 31, 2019, respectively.
Our Company monitors our mix of short-term debt and long-term debt regularly. From time to time, we manage our risk to interest rate fluctuations through the use of derivative financial instruments. The Company has entered into interest rate swap agreements and has designated these instruments as part of the Company's interest rate cash flow hedging program. The objective of this hedging program is to mitigate the risk of adverse changes in benchmark interest rates on the Company's future interest payments. As of September 25, 2020 and December 31, 2019, we did not have any interest rate swaps designated as a cash flow hedge.
The following tables present the pretax impact that changes in the fair values of derivatives designated as cash flow hedges had on other comprehensive income ("OCI"), AOCI and earnings (in millions):
Gain (Loss)
Recognized
in OCI		 Location of Gain (Loss) Recognized in Income Gain (Loss) Reclassified from AOCI into Income
Three Months Ended September 25, 2020
Foreign currency contracts $ (84) Net operating revenues $ (21)
Foreign currency contracts (4) Cost of goods sold 2 
Foreign currency contracts —  Interest expense (6)
Foreign currency contracts 122  Other income (loss) — net 100 
Interest rate contracts 9  Interest expense (14)
Commodity contracts (2) Cost of goods sold (1)
Total $ 41  $ 60 
Three Months Ended September 27, 2019
Foreign currency contracts $ 71  Net operating revenues $ (5)
Foreign currency contracts 3  Cost of goods sold 2 
Foreign currency contracts —  Interest expense (3)
Foreign currency contracts (46) Other income (loss) — net (46)
Interest rate contracts (30) Interest expense (10)
Commodity contracts 1  Cost of goods sold — 
Total
 $ (1)   $ (62)

Gain (Loss)
Recognized
in OCI		 Location of Gain (Loss) Recognized in Income Gain (Loss) Reclassified from AOCI into Income
Nine Months Ended September 25, 2020
Foreign currency contracts $ (61) Net operating revenues $ (22)
Foreign currency contracts 6  Cost of goods sold 7 
Foreign currency contracts —  Interest expense (10)
Foreign currency contracts 21  Other income (loss) — net 71 
Interest rate contracts 21  Interest expense (35)
Commodity contracts (2) Cost of goods sold (1)
Total $ (15) $ 10 
Nine Months Ended September 27, 2019
Foreign currency contracts $ 44  Net operating revenues $ 2 
Foreign currency contracts 1  Cost of goods sold 9 
Foreign currency contracts —  Interest expense (7)
Foreign currency contracts (99) Other income (loss) — net (139)
Interest rate contracts (47) Interest expense (30)
Commodity contracts 1  Cost of goods sold — 
Total
 $ (100)   $ (165)
As of September 25, 2020, the Company estimates that it will reclassify into earnings during the next 12 months net losses of $119 million from the pretax amount recorded in AOCI as the anticipated cash flows occur.
Fair Value Hedging Strategy
The Company uses interest rate swap agreements designated as fair value hedges to minimize exposure to changes in the fair value of fixed-rate debt that results from fluctuations in benchmark interest rates. The Company also uses cross-currency interest rate swaps to hedge the changes in the fair value of foreign currency denominated debt relating to changes in foreign currency exchange rates and benchmark interest rates. The changes in the fair values of derivatives designated as fair value hedges and the offsetting changes in the fair values of the hedged items are recognized in earnings. The ineffective portions of
these hedges are immediately recognized in earnings. When a derivative is no longer designated as a fair value hedge for any reason, including termination and maturity, the remaining unamortized difference between the carrying value of the hedged item at that time and the face value of the hedged item is amortized to earnings over the remaining life of the hedged item, or immediately if the hedged item has matured or has been extinguished. The total notional values of derivatives related to fair value hedges of this type were $12,212 million and $12,523 million as of September 25, 2020 and December 31, 2019, respectively.
The Company also uses fair value hedges to minimize exposure to changes in the fair values of certain available-for-sale securities from fluctuations in foreign currency exchange rates. The changes in the fair values of derivatives designated as fair value hedges and the offsetting changes in the fair values of the hedged items due to changes in foreign currency exchange rates are recognized in earnings. As a result, any difference is reflected in earnings as ineffectiveness. The total notional value of derivatives related to fair value hedges of this type was $499 million as of September 25, 2020. As of December 31, 2019, we did not have any fair value hedges of this type.
The following tables summarize the pretax impact that changes in the fair values of derivatives designated as fair value hedges had on earnings (in millions):
Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss)
Recognized in Income
Three Months Ended
September 25,
2020		 September 27,
2019
Interest rate contracts Interest expense $ 94  $ 206 
Fixed-rate debt Interest expense (97) (200)
Net impact to interest expense   $ (3) $ 6 
Foreign currency contracts Other income (loss) — net $ 3  $ — 
Available-for-sale securities Other income (loss) — net (3) — 
Net impact to other income (loss) — net $ —  $ — 
Net impact of fair value hedging instruments $ (3) $ 6 
Hedging Instruments and Hedged Items Location of Gain (Loss) Recognized in Income Gain (Loss)
Recognized in Income
Nine Months Ended
September 25,
2020		 September 27,
2019
Interest rate contracts Interest expense $ 284  $ 647 
Fixed-rate debt Interest expense (281) (637)
Net impact to interest expense   $ 3  $ 10 
Foreign currency contracts Other income (loss) — net $ 3  $ — 
Available-for-sale securities Other income (loss) — net (3) — 
Net impact to other income (loss) — net $ —  $ — 
Net impact of fair value hedging instruments $ 3  $ 10 
The following table summarizes the amounts recorded in the condensed consolidated balance sheets related to hedged items in fair value hedging relationships (in millions):
Carrying Value of Hedged Items
Cumulative Amount of Fair Value Hedging Adjustments Included in Carrying Value of Hedged Items1
Balance Sheet Location of Hedged Items September 25,
2020		 December 31,
2019		 September 25,
2020		 December 31,
2019
Cash and cash equivalents $ 294  $ —  $ —  $ — 
Marketable securities 201  —  —  — 
Current maturities of long-term debt 2,038  1,004  (2) 5 
Long-term debt 10,685  12,087  670  448 
1 Cumulative amount of fair value hedging adjustments does not include changes due to foreign currency exchange rates.
Hedges of Net Investments in Foreign Operations Strategy
The Company uses forward contracts and a portion of its foreign currency denominated debt, a non-derivative financial instrument, to protect the value of our net investments in a number of foreign operations. For derivative instruments that are designated and qualify as hedges of net investments in foreign operations, the changes in the fair values of the derivative instruments are recognized in net foreign currency translation adjustments, a component of AOCI, to offset the changes in the values of the net investments being hedged. For non-derivative financial instruments that are designated and qualify as hedges of net investments in foreign operations, the change in the carrying value of the designated portion of the non-derivative financial instrument due to changes in foreign currency exchange rates is recorded in net foreign currency translation adjustments. Any ineffective portions of net investment hedges are reclassified from AOCI into earnings during the period of change.
The following table summarizes the notional values and pretax impact of changes in the fair values of instruments designated as net investment hedges (in millions):
Notional Amount Gain (Loss) Recognized in OCI
as of Three Months Ended Nine Months Ended
  September 25,
2020		 December 31, 2019 September 25,
2020		 September 27,
2019		 September 25,
2020		 September 27,
2019
Foreign currency contracts $ —  $ —  $ (23) $ 13  $ (4) $ 42 
Foreign currency denominated debt 12,699  12,334  (445) 476  (452) 444 
Total $ 12,699  $ 12,334  $ (468) $ 489  $ (456) $ 486 
The Company did not reclassify any gains or losses related to net investment hedges from AOCI into earnings during the three and nine months ended September 25, 2020 and September 27, 2019. In addition, the Company did not have any ineffectiveness related to net investment hedges during the three and nine months ended September 25, 2020 and September 27, 2019. The cash inflows and outflows associated with the Company's derivative contracts designated as net investment hedges are classified in the line item other investing activities in our consolidated statement of cash flows.
Economic (Non-Designated) Hedging Strategy
In addition to derivative instruments that are designated and qualify for hedge accounting, the Company also uses certain derivatives as economic hedges of foreign currency, interest rate and commodity exposure. Although these derivatives were not designated and/or did not qualify for hedge accounting, they are effective economic hedges. The changes in the fair values of economic hedges are immediately recognized in earnings.
The Company uses foreign currency economic hedges to offset the earnings impact that fluctuations in foreign currency exchange rates have on certain monetary assets and liabilities denominated in nonfunctional currencies. The changes in the fair values of economic hedges used to offset those monetary assets and liabilities are immediately recognized in earnings in the line item other income (loss) — net in our consolidated statement of income. In addition, we use foreign currency economic hedges to minimize the variability in cash flows associated with fluctuations in foreign currency exchange rates, including those related to certain acquisition and divestiture activities. The changes in the fair values of economic hedges used to offset the variability in U.S. dollar net cash flows are recognized in earnings in the line items net operating revenues, cost of goods sold or other income (loss) — net in our consolidated statement of income, as applicable. The total notional values of derivatives related to our foreign currency economic hedges were $6,069 million and $4,291 million as of September 25, 2020 and December 31, 2019, respectively.
The Company also uses certain derivatives as economic hedges to mitigate the price risk associated with the purchase of materials used in the manufacturing process and vehicle fuel. The changes in the fair values of these economic hedges are immediately recognized in earnings in the line items net operating revenues, cost of goods sold, or selling, general and administrative expenses in our consolidated statement of income, as applicable. The total notional values of derivatives related to our economic hedges of this type were $511 million and $425 million as of September 25, 2020 and December 31, 2019, respectively.
The following tables present the pretax impact that changes in the fair values of derivatives not designated as hedging instruments had on earnings (in millions):
Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Gain (Loss)
Recognized in Income
Three Months Ended
September 25,
2020		 September 27,
2019
Foreign currency contracts Net operating revenues $ 2  $ 15 
Foreign currency contracts Cost of goods sold (17) 2 
Foreign currency contracts Other income (loss) — net 53  (21)
Interest rate contracts Interest expense 2  — 
Commodity contracts Cost of goods sold 34  (60)
Other derivative instruments Selling, general and administrative expenses 20  4 
Other derivative instruments Other income (loss) — net —  5 
Total   $ 94  $ (55)
Derivatives Not Designated as Hedging Instruments Location of Gain (Loss) Recognized in Income Gain (Loss)
Recognized in Income
Nine Months Ended
September 25,
2020		 September 27,
2019
Foreign currency contracts Net operating revenues $ 64  $ 2 
Foreign currency contracts Cost of goods sold 10  4 
Foreign currency contracts Other income (loss) — net (33) (46)
Interest rate contracts Interest expense 2  — 
Commodity contracts Cost of goods sold (33) (58)
Other derivative instruments Selling, general and administrative expenses (12) 32 
Other derivative instruments Other income (loss) — net (55) 39 
Total   $ (57) $ (27)